Competition and Loan Contracting: Evidence From Covenants and Performance Pricing

50 Pages Posted: 19 Mar 2014 Last revised: 22 Mar 2024

See all articles by Xunhua Su

Xunhua Su

Norwegian School of Economics (NHH)

Einar C. Kjenstad

affiliation not provided to SSRN

Xiaoyu Zhang

Vrije Universiteit Amsterdam (VU Amsterdam)

Date Written: September 1, 2021

Abstract

Product market threats shape loan contracting, in particular, performance-sensitive provisions, through two possible channels: A predation channel where the optimal loan contract, in light of rivals’ incentives to undertake predatory strategies, must lower the use of performance sensitive terms to avoid the adverse effects of triggering these terms; and a governance channel where competition mitigates borrowers’ agency issues, and hence reduces the demand for bank monitoring through performance-sensitive terms. Both channels predict a negative effect of product market threats on loan performance-sensitivity. We provide strong empirical evidence for this prediction by studying covenants and performance-pricing. Based on evidence from covenant violations and borrower vulnerability to product market competition, we further show that the predation channel is the dominating channel.

Keywords: competition, covenants, performance pricing, bank loans, governance

JEL Classification: G20, G21, G30, G32, L10, L20

Suggested Citation

Su, Xunhua and Kjenstad, Einar C. and Zhang, Xiaoyu, Competition and Loan Contracting: Evidence From Covenants and Performance Pricing (September 1, 2021). Available at SSRN: https://ssrn.com/abstract=2410568 or http://dx.doi.org/10.2139/ssrn.2410568

Xunhua Su

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway

HOME PAGE: http://sites.google.com/site/xunhuasu/

Einar C. Kjenstad (Contact Author)

affiliation not provided to SSRN

Xiaoyu Zhang

Vrije Universiteit Amsterdam (VU Amsterdam) ( email )

De Boelelaan 1105
Amsterdam, North Holland 1081 HV
Netherlands

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